ECB, BOJ Fighting a Zero Sum Battle

Looking at the contrasting fortunes of Japan and the euro zone over the past year suggests that’s the way things are playing out.

Clearly economic output isn’t a fixed quantity. Economies grow with populations, trade and innovation. But during recent years both the euro zone and Japan have been characterised by low or declining populations and a general lack of innovation.

Meanwhile, the effect of trade has been equivocal. More trade tends to boost economic output. But with domestic demand running at subdued levels in both Japan and the euro zone, both Japanese and European policymakers have attempted to grow their economies by boosting their net trade positions, in other words, trying to sell more abroad than they import.

To that end, Japan has made massive policy efforts to depreciate the yen–it’s fallen 15% in trade-weighted terms since the start of 2013. But because currencies are a zero sum game, a falling yen has translated into a rising euro, which is up some 5% over the same period.

Japan’s explicit reason for depreciating the yen wasn’t to make Europeans worse off. Rather, it was to end Japan’s chronic deflation by boosting inflation.

And Japanese inflation has, indeed, risen. In April inflation rose by its fastest annual pace in 23 years. Although this number was distorted upward by an increase in the national sales tax during the month, the underlying inflation rate was still solidly positive at 1.5%. And more than double the euro zone’s 0.7% rate during the same month.

The European Central Bank’s policy makers have made it clear that they’re worried about the single currency region slipping into a deflationary spiral. They’re also concerned about the euro’s appreciation. To which end, the ECB is likely to introduce further monetary measures at next week’s meeting.

Maybe now that the Bank of Japan’s chiefs have decided it will hold off pressing the policy levers during the rest of this year, it could be the ECB’s turn to play win the zero sum game for a change.